What do Qantas, BlueScope Steel, Rio Tinto and AMP have in common? Yes, each is a big, blue-chip company with a share price pummelled by a savage market. But they also featured on a list of businesses I cautioned against buying or holding more than a year ago. As the table shows, some of the price falls have been truly terrifying.
The market fell about 15 per cent from April last year to the end of the financial year, but this prophetic portfolio of nine hand-picked poor performers was down 33 per cent on average. These businesses haven't fallen because of unfavourable macro factors.
They've fallen because they are poor businesses that were trading at rich prices. So, do any of these stocks offer an opportunity? And are there any other poor, overpriced businesses to avoid?
Dodging poor performers such as BlueScope is critical to successful investing. If a share price falls 80 per cent, you need a four-bagger to recover. Instead of compounding gains, losses like this amplify pain.
In 2005 BlueScope announced net profit after tax of almost $1 billion. Last year, it lost $1 billion. This year it will lose even more. There may be a price at which a canny investor buys a poor business such as this but I prefer to avoid them altogether.
That view is shared by Selector Funds Management founder Tony Scenna, albeit with a caveat. "I would look at a terrible business but only those that have been hit by hard times rather than crunched by terrible metrics," he says. "Qantas and BlueScope, for example, have historically generated returns that rarely exceed the cost of capital. Why take the risk?"
Even the 11 per cent drop in ANZ's share price isn't enough to calm my concerns about foreign expansion, Australian banks' reliance on foreign funding and the possibility of a residential property downturn.
As for BHP, lower prices and volumes could still hit profitability if China slows. I wouldn't want to own BHP at this price and would rather be short than long. But at least part of my concern now seems to be reflected in the price.
There are Intelligent Investor analysts prepared to buy poor businesses at the right price.
Resources analyst Gaurav Sodhi says: "Business quality, if it's real, isn't hard to disguise, which is why the most extreme mispricings are often found in businesses with average economics or worse. Bad businesses can be purchased very cheaply, but it's risky."
Having warned of yesterday's ticking bombs, what of today's?
Upgrade for some
Crown, JB Hi-Fi, Harvey Norman, Fortescue Metals and Transpacific Industries have been singled out by my analytical team as blue-chips to avoid. Mining services stocks also feature. But overall, there is far less urgency to sell now.
The bombs haven't disappeared but equity prices better reflect the risks of hanging in.
That investors are unwilling to pay for optimism says something about the state of the market. The argument for selective buying has therefore strengthened in the past year or so. I'm getting quite excited by the growing pessimism. There are a slew of high-quality stocks I'd like to upgrade, including Coca Cola Amatil, Cochlear, CSL, BHP, News Corp, Woodside, Reece and ResMed.
As for stocks suitable for purchase now, QBE, Computershare, ASX and Woolworths are already available at attractive prices, with each well-supported by a healthy dividend.
Right now, there is simply no need to take on big risks.